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GCP Applied Technologies inc (NYSE:GCP)
Q2 2021 Earnings Call
Aug 5, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the GCP Applied Technologies Q2 2021 Earnings Conference Call. [Operator Instructions] I'd now like to turn the conference over to William Kent, VP of Investor Relations. Please go ahead.

William Kent -- Vice President of Investor Relations

Thank you. Hello, everyone, and thank you for joining us on today's call. With me on the call are Simon Bates, President and Chief Executive Officer; and Craig Merrill, Chief Financial Officer. If you've not done so already, please go to our website, gcpat.com and click on the Investors tab to obtain copies of our earnings release, which contains tables with our financial results, along with a slide presentation with supporting materials. Some of our comments today will include forward-looking statements under the U.S. Federal Securities Law. Actual results may differ materially from those projected or implied due to a variety of factors, including, but not limited to, the impacts of COVID-19. We refer everyone to our more robust forward-looking statement disclaimer and discussion of these risk factors facing our business in our earnings release and SEC filings.

We will discuss certain non-GAAP financial measures, which are described in more detail in our earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the Q&A. References to EBITDA refer to adjusted EBITDA, references to EBIT refer to adjusted EBIT, and references to margin refer to adjusted gross margin, adjusted EBITDA margin or adjusted EBIT margin as defined in our press release. All revenues and associated growth rates in this discussion are stated on a comparable constant currency basis, which adjusts for the impact of foreign currency. I will now turn the call over to Simon.

Simon Bates -- President and Chief Executive Officer

Thanks, Will. Good morning, and thank you for joining today's call. We continue to make substantial progress during the quarter on our strategic priorities of building out our organizational capability and making the right investments to improve our overall competitiveness so that we can grow our revenues and profit margins. I'd also like to note that I have received several questions from our customers' investments on our commitment to the environment. GCP has a very powerful sustainability story. Our construction chemicals and VERIFI business reduced the CO2 footprint for our customers every day. Our building products form an envelope against fire, moisture, vapor and air, making them more energy-efficient and extending the lives of the buildings constructed. You'll hear more about our exciting sustainability story going forward.

I do consider this year to be one of the tougher working environments that I have experienced. Why do I say that? Well, we have multiple daily interruptions in our supply chain for raw materials, packaging and transportation, and we have an incredibly tight labor market impacting all our regions. This is exacerbated by significant input cost inflation and the continued challenges from the COVID-19 pandemic. Therefore, I really want to acknowledge and thank the GCP team on delivering very solid results for the second quarter. These results were achieved through the hard work of all of our employees who have kept their focus on meeting customers' needs despite their daily challenges. Given this backdrop and the strategic changes that we, as a management team are making to the business, our folks should be very proud that we delivered the strongest first half performance since 2018.

Moving on to our strategic objectives. As in past calls, we believe it is important to discuss some progress that we continue to make. Building organizational capability is imperative to our success, and I wanted to highlight that we hired David Campos this past week to run our SCC business for North and South America. David is originally from Colombia and has a management degree from MIT and a long track record of success in the roles and industries he has operated in. We welcome David and know that he will bring a fresh perspective to our business, and will focus on improving the level of service to our customers, enhancing our product portfolio and growing the revenue and profitability of our SCC business in the Americas. As part of our focus on investing to win, we continue to progress with the relocation of our headquarters to the metro Atlanta area, which we announced in March.

We will be partially operational at our new headquarters in Q3 this year and fully staffed in Q1 next year. This move will improve our competitiveness and reduce our G&A costs. We expect to end all of our business activities at our current Cambridge location in September and to complete the move of our R&D and technical support groups to our new Metro Boston location by the end of this year. Our new R&D space will be a significant improvement in design and space allocation and will foster collaboration and most importantly, innovation. Before turning the call over to Craig, I'd like to spend some additional time on what we see in our global markets. While our second quarter results were quite good, we and our competitors and most other industries are facing a barrage of ongoing business disruptions, whether it be labor or raw material shortages, price increases or logistical challenges.

Of most concern is our ability to mitigate the cost inflation we forecast for the second half of this year. We have announced multiple price increases in all regions to offset these impacts and have an extensive global program to drive productivity improvements that we review weekly. However, inflation is currently moving ahead of our mitigating actions, and we expect margin compression in Q3 and Q4 as our actions have not yet caught up to the costs. Despite the near-term challenges, we believe the strategic actions we are taking are reflected in the improvement in the first half results for revenue and profit. I'd now like to turn the call over to Craig.

Craig Merrill -- Chief Financial Officer

Thank you, Simon. Good morning, everyone, and thank you for joining us today. As a reminder, all sales and associated growth rates in my comments are on a constant currency basis. I will discuss GCP's second quarter results, including comments on each of our business segments. And lastly, I will provide commentary with a general outlook for the second half of 2021. Before I get started, I want to give you a brief update on our progress with respect to the remediation of the year-end material weaknesses identified in our 2020 10-K. The summary progress to-date is outlined in our 2021 10-Q quarter two report. In addition to engaging an outside financial and compliance consulting firm to support the development and redesign of a number of our financial controls, we have hired a new North American Controller and a new SOX financial leader based in Atlanta during quarter two.

Both have significant experience in their respective roles and experience with public company accounting and compliance requirements. We continue to resource the remediation efforts with the highest priority, and we will update you on progress as we move through the year. Now moving to the second quarter financial results. GCP's constant currency sales of $244.8 million were 25.3% higher than prior year, generally in line with our expectations as we saw higher volumes from increased construction activity globally. This activity drove revenue growth in all regions. Price for the quarter improved 1.2% compared with second quarter 2020 as price started to come through from our actions. GCP's gross margin decreased 290 basis points to 36.7% as higher raw material and logistic costs started to ramp-up at a higher rate than our Q2 forecast.

Selling and general administration costs of $64.2 million decreased approximately 3% during the quarter and were in line with our expectations due to a favorable net effect of the shareholder activism expenses in Q2 2020 and lower employee-related costs resulting from restructuring. These impacts were partially offset by higher employee incentive compensation costs, in line with higher revenue and profit in the first and second quarter of 2021 and higher facility costs related to the Cambridge corporate headquarters. GCP's income from continuing operations attributable to GCP shareholders totaled $10.4 million compared with a negative $700,000 loss for second quarter 2020. The increase was primarily attributable to higher gross profit due to volumes. GCP's adjusted EBIT totaled $26.9 million compared with $14 million in prior year quarter, up approximately 92%.

Adjusted EBIT margin improved 340 basis points to 10.6% due to higher SCC and higher SBM operating income. Adjusted EBITDA margin was 15% for the second quarter were 180 basis points higher versus the same period in 2020 and our best second quarter margin performance since 2017. Net cash provided by operating activities from continuing operations during the second quarter 2021 was $20.3 million compared with $5.6 million for 2020. We had strong collections in the quarter sequentially and versus prior year, which helped offset higher inventories as we work through the significant supply chain disruptions globally. And we have decided to carry increased inventory levels to better service our customers during this time. Our capital spending for the quarter was within forecast range at $6.8 million and down approximately 30% versus prior year of $9.6 million.

Year-to-date, we are at $21 million of net cash provided by operating activities versus $20 million year-to-date prior year. Now looking at the specific performance of our two segments for the second quarter. SCC's constant currency sales were up approximately 20.5% to $139.7 million due to higher sales volumes. All regions grew with strong revenues year-over-year, specifically around global cement products, Ductilcrete and our Latin America and European businesses with share gains in certain categories and countries. However, SCC's gross margin declined year-over-year by 330 basis points to 36.1% in the second quarter due to higher raw material costs, partially offset by improved operational productivity and price. SCC gross margins will be unfavorably impacted throughout the remainder of the year in comparison to 2020 due to the inflation headwinds in raw material prices globally as our price increases will take time to overcome the impacts throughout the remainder of the year.

SCC segment operating income was $15.3 million, with segment operating margin of 10.6%, an increase of 200 basis points compared with the prior year quarter due to higher sales volumes, positively impacting operating leverage, partially offset by lower gross margin. Turning to the SBM segment for the quarter. SBM sales, constant currency, totaled $105.1 million during the second quarter, a 32.2% improvement versus the second quarter 2020. North America residential roofing demand strength continued, supporting our residential product group with revenues up 41% year-over-year. Global commercial and infrastructure projects ramped up and our building envelope product group revenues were up 29%, including Stirling Lloyd products, up 82%. Our specialty construction products group revenues were up 34%, including our injections products, up 61% and our fireproofing product revenues up 31%, all versus prior year quarter two.

We have made good progress in improving our overall customer service, specifically in North America, Specialty Building Materials segment, focused on customer service with an improvement in on-time and in full shipments to our customers. SBM's gross margin decreased 240 basis points to 38.1% compared with the second quarter of 2020 due to higher raw material costs. SBM's segment operating income totaled $19.9 million, with operating margins at 18.3%, a 370 basis point improvement versus prior period year. The improvement was due to higher sales volume, resulting in improved operating leverage. Now looking forward to the third quarter and beyond. Due to the current supply chain disruptions globally, impacting the construction market, particularly the commercial and infrastructure markets, we now believe our third quarter volumes will be approximately flat to prior year.

Although the demand is strong, we do believe in the short term, construction projects will be impacted by the supply disruptions as the projects will struggle to ramp at the same speed they did in Q2. As an example, the GCP supply chain has been impacted by 28 Force Majeure declarations by our vendors globally year-to-date and 14 Force Majeures continue to be in place as of the end of Q2. We are holding increased inventories to support our customers' demand. However, we continue to expect a volatile supply dynamic within the global construction supply chain over the next two quarters. By the end of the year, we expect the supply chain disruptions to ease, and we see solid opportunities in both the commercial and infrastructure markets globally in 2022, including favorable impacts from a U.S. infrastructure bill, which will positively impact certain specialty building material product lines and our specialty construction chemicals segment.

Until then, we expect our gross margins in the second half to compress as raw material and freight inflation continued to impact financial performance in the short term. Price increases have been implemented. However, it will take a couple of quarters for price to overcome inflation. Due to the significant inflation, adjusted EBIT is expected to be approximately 30% lower in quarter three versus prior year, all due to lower gross margins based on our current inflation forecast, partially offset by price. The impacts on gross margins are expected to be more unfavorable on the SCC segment versus the SBM segment as approximately 2/3 of our inflation is impacting our SCC segment. SG&A expenses for both the third quarter of 2021 and the full year will be approximately flat to prior year.

Our announced restructuring program in March will mostly impact 2022 with a $10 million to $12 million reduction in operating expenses expected in 2022. Our expense management and restructuring programs remain on track. Cash management is a priority, and we are on track to our forecast. Our capital expenditures will continue to be lower versus historical trends. And although inventories are higher due to the inflation impacts on raw materials, we are seeing the benefits of our investments in technology, which are supporting accounts payable and accounts receivable working capital performance, which is helping to deliver on our working capital targets. In closing, we are very pleased with our progress on revenues as we expect to end the year up 6% to 8% higher in revenues versus prior year, with a more focused approach on our customer requirements.

We expect our EBIT and EBITDA to be up versus prior year full year, driven by higher volumes, leverage and lower costs, excluding incentives. However, the benefits of the organization's strategic initiatives over the past year are expected to be partially offset versus our original year forecast due to the increased material and freight inflation. In closing, our strong balance sheet will continue to strengthen throughout the year and is providing flexibility and opportunity to deliver shareholder value, whether it be M&A or capital return to shareholders were a combination as we focus on growth and value, both organically and inorganically. Thank you. And now I'll turn it back to Simon.

Simon Bates -- President and Chief Executive Officer

Thanks, Greg, and thank you all for your time today. We are very pleased with the progress that the business has made in the first half of the year. And once again, my thanks to our employees who focus on the customer every day despite the unusual challenges that 2021 has brought. Although we forecast margin compression for the rest of the year, we estimate that without the significant impact of cost inflation that our trajectory was to grow profitability by approximately 15% year-over-year, a testament to all of our hard work. Our primary focus remains on implementing positive change, and we intend to maintain our transparent dialogue with all of our stakeholders. Our goal is to make GCP a stronger and more competitive company. And clearly, our cash position gives us tremendous optionality, as Greg mentioned, both organically and through acquisitions.

Thank you all for joining our call, and we look forward to taking any questions.

William Kent -- Vice President of Investor Relations

Operator, we can now begin the question-and-answer session.

Questions and Answers:

Operator

[Operator Instructions] The first question comes from Steven Martin from Monness Crespi. Please go ahead Steven.

Chris Shaw -- Monness Crespi -- Analyst

Can you hear me? It's Chris Shaw. I don't know where Steven Martin came from.

Craig Merrill -- Chief Financial Officer

Yes, sorry, we just -- I don't know if we couldn't hear you so.

Chris Shaw -- Monness Crespi -- Analyst

Again, this is Chris Shaw from Monness, Crespi. I'm not sure where the name Steve Martin came from.

Simon Bates -- President and Chief Executive Officer

We had a strange musical, but we're back.

Chris Shaw -- Monness Crespi -- Analyst

I guess just -- I kind of wanted to just get a better idea of the state of the industry in terms of maybe demand, volumes. I mean, if you look back, your sales are still below, say 2019 levels for the same period. And I assume there's been some pricing inflation in there over time. So volume is probably down since then. And just where are we on the trajectory of the recovery and sort of commercial restruction? And where do you see it coming from there? And just get back to 2019 levels by next year? Or is the industry depressed for some other reason that I'm not seeing right now?

Craig Merrill -- Chief Financial Officer

Yes. Chris, it's Craig. And Simon probably will want to weigh in. But just on compared for the GCP comparables, the 2019 would have had some of the exit country revenue in it. So it's tough to compare our 2019 to 2021 specifically because we were still running through some exit country in 2019. But on the general industry, I think if you look at the data, which we stay pretty close to, you are seeing -- 2019 was the most, the highest construction spend. That was the peak of the construction spend historically. And we're a little shy, I think, globally on that, on the trajectory going through to the end of the year, global construction spend. And then there was the expectation that in 2022, you would match the 2019. I think construction spend this year is estimated to be at 5% globally. That includes China, 5.1% I think, was the last look. But with that bump versus prior year and plus 2022, where commercial and infrastructure is expected to come back, not only for the U.S. infrastructure bill, but around the world as projects start to get back on track from the COVID-19 and some spending that you would get back to 2019 levels. I hope that helps.

Chris Shaw -- Monness Crespi -- Analyst

It does also -- do you know -- globally, I know obviously U.S., but are there sort of recovery project or recovery incentives in other economies where it's like another infrastructure program basically around in other countries? Is that the kind of thing that people are doing to recover out of COVID, just like the U.S.? Or is it sort of U.S.-centric in terms of that's a big government spending coming out of COVID?

Craig Merrill -- Chief Financial Officer

No. I think some of the other countries may be behind on the organization of that, but they are discussing it. I know Europe is having discussions, and I heard Mexico is having discussions. Unfortunately, at this time, it's tough to implement because of the situation in the COVID-19. U.S. is probably the first out of the box other than China is continuing to try to manage that as they always do. So we foresee in the future that Europe and some of the Latin America countries will start to use their funds as they need to, to invest in infrastructure in the economies. Because they've lost kind of a -- if you think about it, they've almost lost 1.5 years of investment there, and that's not really appropriate.

Chris Shaw -- Monness Crespi -- Analyst

And then can you just remind me the sort of philosophy around potential buybacks and such? I know you obviously have a good balance sheet, you create cash flow. You haven't bought any shares back in a while. So I can't remember what you normally said.

Craig Merrill -- Chief Financial Officer

Yeah, we approved $100 million buyback up to $100 million. We never specifically said when we were going to do it, of course, we're still monitoring that. Of course, we're balancing our balance sheet with M&A opportunities and other opportunities. So we're working through that. So that's still on the table. We just got to work through it on the balance of what other opportunities in M&A there are there versus sending back to shareholders.

Simon Bates -- President and Chief Executive Officer

Yes, Chris, it's an ongoing dialogue and something we discuss with the Board on a quarterly basis. I would go back to your question around -- you're looking for transparency on the global markets and the relative movements of construction. And it's very hard for us to give you that transparency because each of the geographies is moving at different rates. And quite honestly, it's been a little bit stop-start and what's seen, in particular, in Asia Pacific, where as we come out of the pandemic, we've then gone back in some of our key markets into a much more controlled environment and a slowdown in construction activity. So it is a mixed bag. I can tell you broadly, when we look at North America, we continue to see strong residential new construction. Commercial new construction is slightly down year-over-year, but we've seen some positive signs of recovery in the Northeast and on the West Coast. And there's also some share gains that we've achieved during the year. So it's hard for us to really give you that transparency. It is a mixed bag by geography and by segment.

Chris Shaw -- Monness Crespi -- Analyst

Got it, thanks a lot.

Craig Merrill -- Chief Financial Officer

Thanks Chris.

Operator

The next question comes from Jeff Bronchick from Cove Street Capital. Please go ahead Jeff.

Jeff Bronchick -- Cove Street Capital -- Analyst

Good morning everybody. Just a quick question. It was mentioned in the prepared remarks, and there was a reference to achieving long-term goals and shareholder value and all that good stuff through organic and inorganic needs. Is the word in organic a, is that a stock investor relations? Or is that a new inclusion? And are you guys actively looking at things outside of internal improvement?

Simon Bates -- President and Chief Executive Officer

Yes. Jeff, it's Simon. Yes, we absolutely are, we have that excellent situation on our balance sheet. And we do believe there are some opportunities to strategically grow and supplement our competitive position through the right M&A.

Jeff Bronchick -- Cove Street Capital -- Analyst

Now Simon, it's not fair to bust your chops because you're relatively new, but maybe this is a total and Board inclusion. But do you think the company has demonstrated the operational confidence to actually engage in M&A vis-a-vis, and I get it, it's a consolidating industries that building materials, etc. Why do you think that you're capable of doing and have earned the right from the shareholder base, which has not been terribly happy with how many x years to do that vis-a-vis quite the opposite? There's plenty of people out there running around who we're paying outlandish multiples for businesses like yours. Maybe discuss that as a concept?

Simon Bates -- President and Chief Executive Officer

I'd say you're preaching to the converted and often the phrase I use is internally is earning the right to grow, that we have to demonstrate, we have the capability and from a management standpoint, that if we were to consider and do some deals, we've got to be absolutely sure we have the internal capabilities to properly integrate those businesses. I do believe we are building out that capability. I would say based on scale, we have more capability around that in North America currently, and we're building out that capability in our other geographies. But point taken, and it's very clear and any M&A we would do, we would be very disciplined about the right M&A and the right multiples.

Jeff Bronchick -- Cove Street Capital -- Analyst

Thank you very much.

Simon Bates -- President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to William Kent for closing remarks.

William Kent -- Vice President of Investor Relations

Thank you for joining us today on our call. We appreciate your interest in GCP and look forward to speaking with you guys again soon. Thank you very much.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

William Kent -- Vice President of Investor Relations

Simon Bates -- President and Chief Executive Officer

Craig Merrill -- Chief Financial Officer

Chris Shaw -- Monness Crespi -- Analyst

Jeff Bronchick -- Cove Street Capital -- Analyst

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